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Saturday, October 17, 2015

Bullish Technicals and Bearish Fundamentals

In the history of the stock market, the month of October is notoriously known for its bearish overtones. Investors since 1927 seem to want to sell during the first month of the fourth quarter with no apparent pattern to be recognized. Although the bull market since the end of the financial crisis in 2009 has produced Octobers with less capital outflow than those that came before. In fact this year, the first half of the month has boasted capital inflows of almost $1.2 trillion as a result of the recent bullish rally. As a reaction to Fed monetary policy, traders have garnered confidence behind securities that will benefit from the continuation of 0-0.25% interest rates. The averages serving as a litmus test for the trading floor have soared in the first three trading weeks of the new quarter.

Gains in the NASDAQ, the NYSE index, the Russell 2000, the DJIA. and the S&P 500 have surged about 5% with few days of losses. As a result, most of the ground lost from the August correction has been recovered with some questioning the existence of a bubble forming once again. While the gains could be representative of long traders closing out bearish bets, it seems highly unlikely given the volume levels behind the growth. After initially dropping during Oct 14 losses, bullish volume increased through the end of the week for both the Dow Jones Average and the S&P large cap index. Equities haven't been hurt yet by lower corporate earnings that are expected to show up as earnings season progresses.

Nevertheless, technicals may still suggest a more solidified reversal into bullish territory. After a small bullish flag developed in September, we've seen a "break out" coming through the resistance in October. On top of that, volume seems poised to support the growth after a small bearish lapse. A similar pattern can be seen on the S&P 500 chart but with more variability, This may lead some observers to blame technical traders for a false signal especially when fundamental adjustments will be the primary force behind price movements over the next three weeks. This may be especially true for energy companies which are expected to be extremely disappointed by revenue levels as a result of low oil prices. Friday, investors reacted to Schlumberger's moribund revelations with an initial selling session that stabilized to a higher low.

Interestingly enough, the technicals of the oil services company showed bullish signals coming out of Thursday's session, After five straight days of gaining, they peaked above the 50-day average with the possibility of a continuation pattern developing. On Friday, prices dropped below the 50-day trendline to settle at $74.51 (and were briefly trading around $72.50 levels). The bearish day was an obvious result of bearish fundamental data that interrupted the rally. The blue line shows a trendline which could develop after Friday's losses. The potential for a continuation pattern might still be there, but, strong selling pressure developed by the end of the week implicating a reversal. With a Friday that had reacted like the DJIA average, SLB technicals could have been pointing to a bullish price channel seeking to extend gains from the beginning of October. Money flow in volume and the CMF indicator supported the continuation pattern with Oct 14th and 15th showing rising demand in the short-term. The question is, how will poor energy fundamentals affect stock prices that are bullish at the moment? If we take SLB's decliine on Friday of (-2.16%) and apply similar losses to large cap oil stocks, will technicals hold up the bullish trend?

Above, XOI has been charted for the month of October showing the bullish rise and the movement into an apparent continuation pattern. Like SLB, the index seems to have slowed into a price channel which may result in more gains as volume returns to the demand side. The red dotted lines show a -2.00% loss in the hypothitical seting of a poor earnings report. In my opinion. a 2% decrease in stock price might be average for all oil and gas firms as a fundamental adjustment, although, small cap stocks may come out worse. In the initial review of the index model, technicals don't seem to react to poorly to fundamental adjustments of 2%. Trading could be stuck in a continuation pattern for the duration of earnings season, but the improvement of supply data might become an impetus for breakouts. It is not usually the case that fundamentals and technocals disagree,but the divergence of the two can represent misinformation in teh pricing mechanism. When comparing past patterns and current situations, the strength and priority of the information behind the move is important to deciding an overall trend. On the trading floor, investors must recognize that the division in trading type can create relevant deviations in price expectations. For example, price can jump during bearish fundamental situations as technical traders cash in positions with notable limit levels, and fundamental traders can sell a security when bad news is revealed even in a period of technical strength. For oil and gas companies, I see the bullish technical side coming out on top as low revenues are expected and supply issues will improve.